The President's 2005 Budget: Permanent Tax Cuts and a More Prosperous Future

About the Author

William W. BeachDirector, Center for Data Analysis and Lazof Family FellowCenter for Data Analysis

On February 2,
President George W. Bush proposed one of the most far-reaching
economic growth plans in the past 30 years, calling for all of the
major elements of his 2001 and 2003 tax cut laws to be made
permanent. Permanence will make even more certain that the current
economic recovery continues to be strong. Congress should not
squander this chance for a more prosperous future by allowing these
tax cuts to expire.

Pro-Growth
Components

The tax policy
changes of 2001 and 2003 created a new policy environment for
economic growth. By significantly lowering tax rates on labor and
capital, President Bush increased the likelihood that the U.S.
economy would be more productive and that incomes across the
population would rise.

Congress now has
before it, in the President's budget submission, a plan to make
these tax changes permanent. Specifically, the President calls
for:

Making permanent
the tax policy changes enacted in 2001 and 2003. These changes
include:

Permanent
extension of the individual income tax rate reductions enacted in
2001 and currently scheduled to disappear in 2011;

Permanent
extension of the lower tax rates on income from capital gains and
dividends that were enacted last year and are currently set to
expire at the beginning of 2009;

Permanent repeal
of the federal estate tax and the generation-skipping transfer tax
that are scheduled to be re-imposed in 2011; and

Permanent
extension of the child tax credit, the marriage penalty relief,
small-business expensing, and a host of pro-growth and tax equity
elements contained in the landmark tax acts of 2001 and 2003.

Expanding the
amount of income that can be placed in long-term, tax-advantaged
savings accounts. The President has proposed a Lifetime Savings
Account and a Retirement Savings Account, both of which will help
build savings and contribute, ultimately, to investment.

These and related
tax policy changes will boost the rate and level of economic
activity by assuring people who work, save, and invest that they
won't face higher taxes in the near future. Taxpayers know that taxes raise the price of
everything. If capital is taxed (as it is when taxes are imposed on
savings accounts, stock dividends, and the value of land and other
tangible assets), it costs more for businesses and homeowners to
borrow money from the bank. The same economics applies to the
taxation of labor and other forms of economic activity: Raising
taxes increases the cost of the activity taxed, which generally
lowers its use.

Thus, when Congress lets a tax cut
expire, it endangers economic growth. Even when it threatens to let
a tax cut expire in the distant future, say 2011, investors both
make plans to put their money into projects that will pay out over
a shorter amount of time and pull out of long-term investments,
like research that will yield results only in 10 years or a new
factory that has to be paid off over a 20-year period. In other
words, investors often view Congress's failure to make a tax cut
permanent as a signal of higher taxes-and thus prices-in the
future.

Achieving
Public Policy Objectives with the Tax CodeIn addition to these pro-growth proposals, the President's 2005
budget contains a number of tax initiatives designed to achieve
specific public policy objectives. Specifically, the President
proposes:

Providing
taxpayers who purchase their own health insurance with tax credits
and income adjustments on their tax returns;

Allowing
taxpayers who currently do not itemize their deductions to take a
deduction for contributions to charitable organizations;

Assisting
taxpayers with their expenses for education, telecommuting, energy,
and housing; and

While these tax
proposals do not contribute as strongly to economic growth (and are
not primarily designed to do so) as the President's plan to make
his previous tax policy changes permanent would do, they
nevertheless address important aspects of everyday life that are
affected by tax policy. Health insurance, for example, is provided
to workers largely by their employers instead of being purchased by
individuals, as homeowners insurance is. This peculiar arrangement
is entirely a product of tax law that allows employers to deduct
the cost of health insurance from their taxable income.

One Wrong
Direction

Even though the
plurality of the President's proposals moves in the right
direction, however, a few do not represent good tax policy.
Specifically, the President's budget would raise taxes on
corporations by eliminating their ability to establish leasing
arrangements with cities and other local governments to manage such
activities as subways, sewer systems, and parks. These leases
generally result in losses that corporations can use to reduce
their taxes. Cutting the ability of local governments to outsource
expensive operations such as these would raise the expenses and
decrease the efficiency of local government.

This proposal for
raising additional revenues from the corporate profits tax would
not lead either to higher economic growth or to a fairer tax
code.

William W.
Beach is Director of the Center for Data Analysis at The Heritage
Foundation.

About the Author

William W. BeachDirector, Center for Data Analysis and Lazof Family FellowCenter for Data Analysis